Friday, December 02, 2005

Platform companies

Economist Brad Setser has been discussing platform companies as the future for US industry. The idea is that high value-add activities such as design, engineering and management are performed here, and low value-add manufacturing is done abroad. A good example of this is the iPod, which was designed in Cupertino but is manufactured in Taiwan. Apple sold $1.2 billion worth of iPods in Q1 2005, making iPods almost as big as their computer business! Apple's margin on iPods is healthy - estimated at up to 20% -- while I am sure the manufacturer's margin is very slim. So, the conventional wisdom goes, let those low cost countries have the cutthroat manufacturing business. We clever Americans will simply go upstream, creating new products and markets through innovation.

There is a problem with this, and it is related to the winners and losers issue that arises in the usual story of comparative advantage. Overall, societies may enjoy a net benefit from trade (heck, there are even "theorems" going back to Ricardo "proving" this), but even in the optimistic cases the benefits (and losses) will be unevenly distributed. As autoworkers are displaced by Delphi moving production to China, investment bankers or consultants in the US benefit from demand for globalization strategists. But who ensures that some of the benefits are redistributed? Of course we all benefit from lower prices for manufactured goods, but that is only partial recompense to an unemployed auto worker.

I would go even further, and guess that only a small fraction of the population in advanced countries has the cognitive capabilities to be on the winning end of this process. That is, the Apple iPod designers, investment bankers, CEOs, etc. who win at this game are very able -- in terms of conventional IQ or special abilities such as leadership, design creativity, etc. It is questionable whether the average person will ever be able to contribute on a "high value-add" team! Instead, they'll be caught in a process taking place over a generation in which low-skill wage costs equilibrate worldwide. The theorems might still be satisfied by the huge returns to very able people (whether in China, India, Russia or the US), but the trend for the average American might be negative. Instead of an auto worker in Detroit earning enough for a good retirement and college education for their kids, they'll instead make $10-20 per hour, including benefits. (See earlier post Equilibration can hurt.)

Previous discussion of outsourcing here and here.


Anonymous said...

Given that the majority of American voters will personally have more to lose from this development, how do you sell it to the public? It seems there are three basic possibilities:

1. What I would call the Krugman option: you tax the winners to compensate the losers.

2. The UAW option: protectionism.

3. The Bush option: you lie to the masses and distract them with shiny objects, all the while exacerbating the problem by shifting the tax burden onto the losers.

I'd personally prefer option 1.

Anonymous said...

Thanks for this post. Free trade good on average, not so hot for the majority. Spread the word ;)

"Taxing the winners to compensate the losers" is a start if it means having the affluent actually pay for the social spending that GWB has hiked so substantially.

But the real kicker to this in my mind is that I totally discount the political possibility of fixing this until the developing world has done a lot of catching up. The losers in America are going to go right on losing (economically) until enough of the world's work has migrated abroad to really equilibrate.

Only after the dollar declines substantially and the American consumer's spending power is cut down to size by loss of credit and lower buying power will things change.

Only then will the marginal "almost decided to major in engineering" type actually be compensated for gaining extra skills. For now it makes more economic sense to flip houses than to try to gain skills that there is decreasing domestic demand for.

And in the meantime: what happens to our civil liberties? What happens to democracy and human rights? The real worry is that the increasing power of developing undemocratic powers like China will define human rights down everywhere else. This has been the tendency with emerging international institutions like the WTO. Lowest-common denominator on all social/rights/environmental issues.

mike reardon said...

Advanced Nations are becoming transactional economies, now only trading platforms for inexpensive world services and goods produced and designed in Lower Wage Nations.

What the Advanced Nations still have in place, their great wealth and financial leverage of world transactions US $11.4 trillion. With increasingly innovative products and process, they can still remove greater profit from home and world markets and enhance the wealth of investors, and replacing the consumer central roll in the economy.

Look for businesses gaining increasing profit to still push off health cost and pension cost as social process they can not be expected to carry, even pushing for one payer government services while still having premium health services for the wealthy.

After 2010 this will be the base for popular demanded social services health and pension supported by government payments. The last payer in the social safety net. Europe and Japan can do this tomorrow, it will take a little longer on this side of the Atlantic.

That is the move to globalization as seen by an old Lyndon Johnson Democrat, looking at what is happening in this capitalist transfer of wealth, it looks a lot like new Reaganonomics.

Anonymous said...

the 'platform company' is a notion promoted by gavekal [summarized here & here, cf.]

an interesting contrast on whether "high value-add activities" can carry an economy can be seen in india. their answer: they cannot...

"Few now argue that India should ignore orthodox models of manufacturing-led development, however tempting it might be to prioritise a service sector that plays to the country’s strengths in human capital and information technology while circumventing its massive infrastructural flaws...

"Sustaining manufacturing growth at 10–12 per cent is a priority for the government, which sees it not just as a second engine of economic growth but also as a tool to tackle one of its biggest headaches: unemployment. Only by boosting manufacturing’s weight in the economy does the government believe it can solve India’s problem of jobless growth.

"While agriculture’s share of GDP has fallen to barely 20 per cent from 32 per cent in 1991 and that of services has soared to 52 per cent from 41 per cent, industry has remained flat at 27 per cent. And within industry, manufacturing has been stagnant at 17 per cent of GDP. The government says this must rise to nearer the 30–35 per cent seen in China, Thailand and Malaysia.

"If 'Made in India' is to live up to these ambitions, however, the government needs to enact a second generation of reforms, giving a warmer welcome to foreign direct investment. India attracted less than $6bn in FDI last year – one-tenth of the amount, most of it in manufacturing, that went to China. Few emerging economies have built a manufacturing base without relying heavily on FDI, as a source of capital and a means of transferring technology and knowhow...

"If a second generation of reforms is undertaken, McKinsey estimates India could lift its share in world trade to 3.5 per cent by 2015, a new global manufacturing hub would be born and millions would be lifted out of poverty at a much faster rate than would otherwise be the case. Without such reforms, India’s infrastructural shortcomings might prove ultimately overwhelming. Mr Kalyani warns that unless the Mumbai-based Maharashtra state government improves the business environment in Pune, the heartland of Indian manufacturing will lose its appeal.

"He has a clear warning policy­makers: 'Today I’m the world’s most competitive forging company, but this city’s population has doubled over the last decade and there have been no new roads. Existing infrastructure is overloaded and has an impact on our costs. In three years’ time, if we are double the size we are today and nothing has changed, this is not going to work. For our next phase of development, we would have to find another site.' "

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